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Debt Consolidation Loans and Different Types of Debt

consolidation.jpgDebt consolidation is a way of combining your debts into one, making them more manageable and easier to keep track of. It can be an effective debt solution for people looking to simplify their finances and/or free up cash each month.

The most common type of debt consolidation is a debt consolidation loan – a new loan to pay off all your existing debts. This loan will then be repaid in single monthly payments to your new lender.

Another big advantage of taking out a debt consolidation loan is that it’s possible to reduce your outgoings. By repaying the loan over a longer period of time than the original debts would have taken to pay off, you can make each monthly payment smaller, freeing up cash for other purposes.

However, keep in mind that the longer you take to repay the loan, the longer you’ll be paying interest, and you could pay more overall as a result. And – as with any loan – it’s vital that you arrange repayment terms you’re confident you can afford.
What types of debt can debt consolidation help with?

In theory, a debt consolidation loan can cover any type of debt that can be repaid early (there may be an ‘early repayment charge’ on certain debts, which you will also have to factor into your calculations when you’re working out whether a debt consolidation loan would be worthwhile).

Secured vs. unsecured debts

It doesn’t really matter whether the debt is secured or unsecured. As long as your debt repayment terms allow for an early repayment, your loan can cover either of these types of debt.

Mortgage debt

Mortgages are large debts and tend to charge lower interest rates than loans, but you could take out a new mortgage with a longer repayment term and/or lower interest rate and reduce the amount you’re paying every month.

If you do decide to remortgage, it may also be possible to borrow extra to pay off your existing debts. This is known as a ‘debt consolidation remortgage’. Be aware, however, that securing any debt against your property can put that property at risk if you fail to keep up with the repayments.

Student debt

A debt consolidation loan can cover debt you took on as a student, but whether it’s worthwhile depends on the type of debt. For example, student loans (from the Student Loans Company) are designed to be repaid in affordable amounts, and you’ll pay nothing at all if you don’t earn enough (currently £15,000 a year).

If you took out a debt consolidation loan to cover this debt, you’d be expected to pay each month regardless of your circumstances. Plus, the interest on a student loan is just linked to inflation, so your student loan – unlike a debt consolidation loan – shouldn’t grow at all ‘in real terms’.

However, if you have other debts from your student days – credit card or overdraft debts, for example – you may find it’s worthwhile to pay these off with a debt consolidation loan.

Is debt consolidation right for me?

Before you take out a debt consolidation loan, consider carefully whether it’s the best option for your circumstances. If you’re unsure, a debt adviser can help you to decide.

Debt consolidation loans are intended for people with manageable debts. They are a way of simplifying your finances and making your monthly payments easier to make. If your debts are causing you real problems now, it’s unlikely that a debt consolidation loan will help, and so you may wish to find out more about alternative debt solutions, such as a debt management plan or IVA (Individual Voluntary Arrangement).

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